Bruce Davis – CEO and Chairman
Mike McConnell – CFO
Bill Gibson – Legend Merchant
Paul Sonz – Sonz Partners
Digimarc Corporation (DMRC) Q1 2013 Earnings Call May 2, 2013 5:00 PM ET
Good afternoon, and thank you for participating in today's conference call. Now I will turn the call over to Bruce Davis, Chairman and CEO of Digimarc. Mr. Davis, please proceed.
Thank you. Good afternoon. Welcome to our conference call. Mike McConnell, our CFO, is with me. On the call today, we'll review and discuss Q1 results, talk about significant business developments and market conditions and provide an update on our strategy and operations. This webcast will be archived in the Investor Relations section of our website.
Please note that during the course of this call, we will be making certain forward-looking statements, including those regarding revenue recognition matters, results of operations, investments, initiatives and growth strategies. These statements are subject to many assumptions, risks, uncertainties and changes in circumstances. Any assumptions we share about future performance represent a point-in-time estimate. Actual results may vary materially from those expressed or implied by such statements. We expressly disclaim any obligation to revise or update any assumptions, projections or other forward-looking statements to reflect events or circumstances that may arise after the date of this call. For more information about risk factors that may cause actual results to differ from expectations, please see the company’s filings with the SEC, including our latest Form 10-K.
Mike will begin by commenting on our financial results. I will then discuss our execution strategy and outlook. Mike?
Thanks Bruce and good afternoon everyone. As we reported a year ago Q1 results last year included an $8 million revenue amount for past-due royalties received from the settlement with Verance. While total revenues in Q1 of 2013 decreased by 40% to 10.2 million from 13 million in 2012, our revenues, excluding the Verance settlement, increased by 13% year-over-year.
Our net income for the quarter was $1 million, or $0.13 per share on diluted basis and the balance sheet remained in excellent shape with more than $40 million in cash and securities and no debt. Q1 results included the first full quarter of operations related to our recent acquisition of Attributor. We made significant progress in integrating the Attributor team and its operations into Digimarc. We also continued to invest in our growth initiatives, including developing and marketing Digimarc Discover, audio and packaging research and development and developing the second wave of patents, all in support of our vision of enabling computers, networks and other digital devices to see here understand and respond to their surroundings.
Looking further in the details of our Q1 2013 financial results. We see that excluding the 8 million of revenue from Verance for past-due royalties in 2012 the majority of our year-over-year growth was due to inclusion of the first full quarter’s operations of Attributor along with the increases in other sources that were offset by elimination of revenues from the Nielsen joint ventures that were suspended in the first quarter of 2012.
In the financial statements that we have broken out, revenue is a bit differently than in prior years. We've historically combined the license and subscription revenue on our income statement. We’ve given the recent significant increase in subscription revenues due to the Attributor acquisition, we’re now presenting license revenue and subscription revenue separately.
Our gross margin was 79%, 10 points lower than the prior year reflecting a greater mix of service revenues to the total where our Q1 last year included a high margin past-due license royalties from Verance. Operating expenses were $6.5 million, being 6% higher than the prior year with most of the increase due to the first full quarter of operations for Attributor and continuing investments in developing and marketing Digimarc Discover, audio and packaging, research and development and developing our second wave of patents. Our operating profit was $1.6 million or 16% of revenues and operating cash flow was $3.4 million or 33% of revenues.
In our last call, we indicated that revenues are likely to be lower in 2013 compared to 2012 primarily due to the $8 million of past-due royalty revenues from Verance in Q1 of 2012 and the quarterly license payments from intellectual ventures ending in Q2 of 2013, partially offset by expected growth in revenues from the acquisition of Attributor, our new agreement with central banks and increases from other customers and new customers in other areas of our business.
We continue to expect the financial results will be below last year’s levels. Since the last conference call we decided to increase staffing in R&D, marketing and intellectual property beyond the levels contemplated in our annual operating plan to accommodate additional growth opportunities that have arisen since the adoption of the plan. Our headcount in December of last year prior to the Attributor acquisition was 107. Taking into account the 19 employee that came with the acquisition, hiring to our annual plan and hiring to accelerating certain investments in R&D, marketing and intellectual property, we expect permanent staff and consultants to exceed 150 by the end of Q3.
We’re allocating these resources, the additional resources to marketing and product development of Digimarc Discover as we look to expand our offering to larger enterprises and broader markets, particularly in support of the shopper experience, bringing the market our packaging and audio offerings and more dedicated research, associated hardware, software and intellectual property development.
The accelerated investments will reduce profits for 2013 and may lead to a GAAP loss for the year depending on the timing of revenue ramps. Our operating cash flow is expected to be positive for the year and we have plenty of capital to fund these and other initiatives that we believe will add significant earnings growth potential in immediate, intermediate and long term basis.
Our dividend program continues unabated. The Board of Directors had declared a quarterly cash dividend of $0.11 per share of the company’s common stock. The dividend is payable on May 20, 2013 to stockholders of record as of the close of business of May 13, 2013.
For further discussions of our financial results and risk and prospects for our business, please see the Form 10-Q that we expect to file very shortly. Bruce will now provide his comments on our execution strategy and outlook.
Thanks Mike. We delivered a considerable increase in shareholder values since the ID system sale in 2008 and the value has increased six-fold in little over four years since the new Digimarc shares began trading post divestiture. That’s why record profits and cash flow, dividends and share repurchases and the share price has been languishing. Long -time shareholders have witnessed such periods over the years. Recognition of increases in value in our business have generally been event driven. There have been several defining moments in our brief 18-year history, including an enquiry from the central banks in ’97 that led to our largest and longest standing customer relationship, the IPO in ’99, acquisition of Polaris large government program business in 2001, sale of that business in 2008, and the intellectual ventures license in 2010. There are signs that another defining moments may be coming soon.
Now to moving faster in a number of fronts as favourable mega trends in our target markets accelerate. Interest in our company and its technologies is growing coincident with this strategy. I will explain what I can when I can though we’d be patient regarding the scope and timing of disclosures that we will be able to make. Given confidentiality obligations we have with various companies and good terms regarding managing business relationships and competitive considerations. We intend to present further details on execution strategy in materials that we posted on our website in mid-May preceded by newswire signalling the availability of the materials.
As we have been saying we are intent on making a significant progress in execution of strategy in 2013. The management team is working diligently to demonstrate and communicate progress on a number of fronts, to describe in the annual plan objectives that we shared with you as well as some new opportunities that have emerged since approval of the plan by the board. It is clear to me that we have entered the phase of significant expansion of the commercialization of our research and development both directly through the provision of software and services and through licensing.
Although we continue to expect that revenues and profits will be lower than last year, we are increasing investments, and not cutting costs as some might expect. We did not come to such decisions lightly and I can fully communicate the basis for these decisions at this point. Or I am confident that this is the best course of action to maximize shareholder value.
This is another potential tipping point for Digimarc. Remember this is in some ways of the investment in growth that we made during 2001-2008, the eight years that led to dramatic increases in shareholder value that greatly surpassed expectations based on the current earnings. (Inaudible) obvious risks that we believe are justified by the scale of the opportunities we are pursuing. I also think that time is of the essence as certain changes in our target markets are moving at greater than speed.
A sense of urgency pervades our operations this year as we consolidate the fruits of the last 15 years of R&D into our robust software platform and associated services while generating substantial patent assets from our increased R&D investments. We remain on track and committed to the most aspects of our previously discussed strategic goals. However we are contemplating two important changes. We are making a significant change in strategy for growth in the area previously known as government programs. The bulk of that area of business will continue to be our central bank customers with whom we recently agreed to a 12-year extension of our contract.
As you know our efforts over the year to expand our footprint in government business into defense and intelligence have been unsuccessful. As previously announced, we pulled back and associated business development initiatives. Since then we have identified and are exploring a potential high growth alternatives for product market expansion. It leverages many aspects of our work at the central banks over the last 15 years and the synergistically we are continuing development of Digimarc Discover. The new direction is based on some home-grown innovations in mobile payments, a market with enormous potential that we think our technology made for growth revolutionary changes in payment processing. We are not ready to provide specifics but wanted to give everyone a head-up that we are anticipating this change in the strategy.
The other strategic change is in the audio field. We’ve made considerable investments in mobile optimized digital wire marketing. The R&D has produced good results. We anticipate a targeting of some business development resources of the music industry in 2013. Based on field trials of our technology and certain changes in relevant markets we are putting our focus to television and radio advertising and in-store audio networks. We’ve completed successful technical trials in actual television and radio broadcast and the mass merchant stores. The results of sufficiently positive to warm to allocation resources. More to come on this too as the year progresses.
Digimarc Discover is the embodiment of our patented intuitive computing platform. We have made good progress in R&D and commercialization as noted for example in our recently published 2012 traction report that chronicles growing adoption of Digimarc Discover in the magazine industry. Usage rates have tripled in the first quarter over the same period a year ago and we’ve added several new customers, including Cooking Light, Real Simple, and the Shopper in this catalogue. Most recently Costco, the nation’s second largest retailer, initiated use of our solution in the April issue of the Member Magazine of the Costco Connection with circulation of over 8 million.
Just released May issue has over 130 Digimarc objects. In parallel, Costco added Digimarc reading capabilities that are popular in mobile app. We are in active discussions to expand that relationship with Costco in accordance with retail strategy as outlined in previous calls. We intend to invent and deliver directly and through licensing on common platform that connects prospects and customers to brands across the full spectrum of the shopper’s journey.
The focus of our market development is on mass merchants, expanding the application of Digimarc Discover for magazines and catalogs, the newspaper inserts, direct mail, packaging, in-store promotion and television and radio advertising. We are making good progress on developing a Digimarc solution for consumer packaged goods. Our packaging and research and development has progressed through collaboration with a major scanner supplier on implementing our software in one of their new imaging scanners.
We’ve begun to get to our access to scanners from other suppliers to assess implementation opportunities and challenges. We continue to work with a consulting firm of experts in the scanning industry to apply this learning from market data to develop a model for positioning, packaging and other aspects of preparing for successful market entry.
As most of you know our long term goal is to become the successor to conventional barcodes for much of the automatic data capture market, including retail checkout, and to deliver to consumers pre- and post-purchase benefits of digitally watermarked packaging and shopper marketing materials.
Licensing will continue to be a key element of monetization of our inventions. All these developments that I've described flow into our patented intuitive computing platform architecture. We see pervasive, intuitive computing as inevitable, expanding and simplifying access to networks across all aspects of everyday life. Eventually, many sensors will contribute to this new means of computer access. But as in human recognition, the eyes and the ears will be key. Our R&D converges in a model of efficient and effective management of resources, supporting the seeing, hearing mobile device and intelligent networks. The markets affected by such improvements in mobile devices are large and diverse, encompassing virtually all media in the world.
As most of you know, we have two waves of licensable IP: The more mature portion of our patent portfolio for which intellectual ventures has an exclusive license to sublicense, and the growing portfolio of retained patents, applications and ongoing R&D to which they have no rights. With respect to the Intellectual Ventures aspect of our licensing program, we're continuing the process to resolve differences of opinion about allocation of revenues and costs that affect our profit participation agreement. Yesterday, we concluded a mediation, the dispute resolution process will continue. We have no further comments on this matter at this time.
As I noted earlier, the retained portfolio is growing at a rapid rate. We now have 47 issued patents and over 300 applications pending. There is a very healthy rate of new fillings flowing from our increased R&D. A key objective of the 2013 plan is to have sufficient licensable IP to project significant new license income sources in 2014. We are pursuing this goal by identifying target markets and specific licensing opportunities within those markets, optimizing the portfolio in relation to the target markets, requesting expedited issuance of high-value claims and preparing for marketing and enforcement, if necessary.
We have exciting prospects and a very ambitious agenda for 2013. We continue to believe that seeing and hearing will become routine functions of mobile computing devices, providing a natural successor for a substantial share of discovery, first realized on a global scale by the keyword search functionality popularized by Google, and now being shaped by the rise of mobile computing.
As I noted in prior calls, the developments that we are pioneering will foster more complete and engaging relationships between retailers, brands and their customers and prospects, providing customer engagement, accountability and access to critical information about their shopping and consumption characteristics. This dovetails nicely with the growing desire of retailers and brands to tell stories of productivity and lifestyle enrichment in the new social networks, and more effectively manage and deliver engaging and rewarding branded experiences to their consumers. It also fits well with the new methods of integrated media marketing, providing consumers with greater flexibility in how, when and where they get products and services, and the information that helps them to make purchase decisions.
In closing, I want to remind everyone that all employees of your company are shareholders. The hallmark of success in 2013 will be patience, perseverance and orchestration. We share a long sight view in the risks and rewards of that strategy. We are fully engaged, energized, excited and confident in our direction.
That's it for our prepared remarks. Now we will open the call to questions.
(Operator Instructions) You have a question from Bill Gibson with Legend Merchant.
Bill Gibson – Legend Merchant
Sort of shrouded the new developments in the sense of hey, we’re working on things we can’t talk about, and then you went off on things such as mobile payments and in-store advertising and TV, and basically an alternative for a barcode. Are the other things you can’t talk about larger than these? We played red basket game.
Now, what I can’t provide at this point in time is names and numbers and details of such things. So for instance in the area, the payments processing area we have been exploring some relationships with some large companies, discussing novel approaches through the mobile payments, that we and they think have promise and it’s just premature to given the details and not permitted by confidentiality restrictions. But it’s quite an interesting area and one of enormous potential and it’s consistent with much of the confidence we’ve developed them are work in security both in the central bank business and in the ID systems business that we divested in 2008.
So it’s just one example, there are several of them as the script notes some which were contemplated in the – some of which have come up since then, or pulled forward in some sense from future periods where we anticipate doing certain things.
You have a question from Paul Sonz of Sonz Partners.
Paul Sonz – Sonz Partners
Bruce, did you say in the call that you would be cash flow breakeven this year despite the increased expenses that you’re taking on?
That was actually Mike’s part of the presentation. As you know we don’t give detailed financial guidance but we expect to be somewhere around that range. And again we have plenty of capital, so there is no capital risk in changes in the plan that we made. So we’re obviously going to grow our staff quite materially this year. That was the main point we were making.
Paul Sonz – Sonz Partners
I think the actual number beyond the people from Attributor would be an additional – I took a quick guess, it was about an extra 35 people above and beyond your normal staff plus the Attributor staff?
But more like 25, we have 107 on the 1st of December, we’ve added 19, and then we’re going to end up over 150.
Paul Sonz – Sonz Partners
Now early on, and as always your scripts are very pack with information and there was one thing that I'd missed. You discussed the fact that your relationship with government business and then I think you went on to discuss how in – with the new opportunities that was -- that focus was going to change to some extent. Could you just go over that again because I didn’t quite get that?
Sure. We have historically described the area of business that includes the central banks as government programs. We will not do that anymore. That’s because there is a different axis of opportunity that we will focus on. So government programs meant that we were seeking to expand our business relations with central banks to other government agencies primarily in defense and intelligence. We’re not going to focus on that. In fact, we told you on our prior call that we were backing off on that because it was proving to be unreliable and difficult and opaque, on and on.
So the central bank business is going to grow nicely this year with expanded margins but what we have discovered through some inventions and some exploration of relationships there is an opportunity that is premise on our confidence in payment processing, and central banks overseas all payment processing. So you can call if you like central bank domain but I don’t mean to imply more business as central banks. What I am talking about here is mobile payments and a novel approach to facilitating greater use of mobile payments.
Paul Sonz – Sonz Partners
That is exciting. If you were to prioritize the new opportunities that you talked about on the call so far, how would you rank them in order of most likely or nearest term and latest revenue I suppose they could be different. But if you were to rank the opportunities in order of what your expectations were, how would you rank them?
I don’t think I can do that, Paul. I believe that the increased resource investments that we’re making is warranted by the portfolio of opportunities that we are working on. But I frankly don't do the exercise of trying to handicap the timing of the outcomes because it really doesn’t do me much good to try to do that. But I think that – the area where things can happen most quickly in terms of upsides that’s difficult to project is in licensing. And the other stuff takes some time to develop. And so I think in terms of services and subscription you should expect that we will able to size indicators of progress that will be leading indicators of growth in profits.
Paul Sonz – Sonz Partners
In the new areas that you're so excited about, are they dependent on the second-generation of your patent portfolio, or is this stuff that’s still going to be dependent on first generation?
It’s both. What we expect to see is that the exponential growth in patents that we have demonstrated since inception will move to an even higher rate of exponential growth. All of the resources that we’re hoping to add are in R&D, IT and sales and marketing. There is no proposed increase in G&A. And so we are already filing an extremely high rate we expect to significantly increase the filing rate through the addition of the R&D and IT resources.
Paul Sonz – Sonz Partners
You mentioned that you are going to have people in sales and marketing. This is new – in a way I think this is sort of a new for Digimarc, to whom will they be marketing and I mean in a general sense, not in specific sense, is this sort of a – they are marketing to half a dozen major corporations or what kind of marketing is it, sales and marketing, if you can discuss that?
I can. So we have increased the sales resources for our e-book business, our magazine publishing business and our retail business. Those are the three areas where there are increases.
Paul Sonz – Sonz Partners
What is the retail business?
It’s the developing area of business that we described as key component of our 2013 strategy and plan, first embodied in terms of public announcements with the adoption by Costco in their member publication of our technology.
Paul Sonz – Sonz Partners
All right. But listen, thank you very much. It’s wonderful to hear you guys so excited about this. And we’re looking forward to hearing – I think you said that there will be more information coming out in mid-May, is that right?
Yeah we plan on posting some additional information about the business in mid-May. I prefer to wait than to describe with anymore specificity of what that is. But we will put some more staff out.
Paul Sonz – Sonz Partners
And are you going to be at any conferences that we should be aware of?
Thank you. This concludes today’s question and answer session. I would now like to turn the call back over to Mr. Davis for any closing remarks.
All right, thank you very much everyone. We will keep up to date to the best of our ability, including any interim announcements that may be appropriately. But we will look forward to giving you another update on the strategy at the end of Q2 in an event. Thanks very much.
Thank you. This concludes your conference. You may now disconnect.
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